Abstract
This paper studies the pricing behaviors of default-free bonds based on the two-factor model by Brennan and Schwartz (1979), where a short-term spot rate and a long-term consol rate are the state variables. The logarithm of these two factors is assumed to follow a linear transformation of an Ornstein-Uhlenbeck process. An exact discrete time model is derived to estimate the parameters in the process. The model prices are then numerically solved. The sensitivity analysis indicates that the long-rate process, especially the long-rate volatility parameter, is important in characterizing the term structure of interest rates.
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Hsin, CW. An empirical investigation of the two-factor Brennan-Schwartz term structure model. Rev Quant Finan Acc 5, 71–92 (1995). https://doi.org/10.1007/BF01074853
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DOI: https://doi.org/10.1007/BF01074853